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Cambridge Economics News from the Cambridge Faculty of Economics Issue 11 Winter 2018 A Good Knight’s Work Distinguished Alumnus: Professor Sir Angus Deaton* Angus Deaton was awarded the 2015 Nobel Prize in Economic Sciences for ‘his analysis of consumption, poverty and welfare’. The citation for his UK knighthood, conferred the following year, was for ‘services to research in economics and international affairs’. Following James Meade and Richard Stone, both of whom were friends and the latter his closest mentor, and after Amartya Sen and James Mirrlees, who spent much of his career at Cambridge, Angus is the fifth Nobel Laureate from Cambridge economics. Cambridge life No-one, including Angus, could have foreseen this outcome when he first came to Cambridge in 1964, from Fettes College in Edinburgh, to read Mathematics. He says he found the subject, as taught, difficult to engage with: he lost interest; played lots of bridge and went to the cinema; did very little work; discovered Cambridge pubs, and consequently fared badly in INSIDE: examinations. From the Editor 3 Professor Sanjeev Goyal 4 By the end of his second year he was on the point The Education Production Function: A Brain Teaser 6 of giving up and leaving Cambridge. But his tutor at The Narrow Corridor to Liberty 8 Fitzwilliam College who, like his father, was anxious to Morality and the Market 10 keep him in the College, persuaded him otherwise, GDP – Grossly Distorted Picture? 12 saying: ‘There is only one thing for people like you – Better Economics Teaching? CORE! 13 Economics!’ The Digital Revolution and the State: The Great Reversal 14 The Economics of Religion in India 15 Systemic Risk-shifting in Financial Networks 16 Continued overleaf... Awards / Obituaries 18 Comings and Goings 20 Distinguished Alumnus Transferring to Part 2 of the in the Coffee Room. But there were model maintains Slutsky symmetry Economics Tripos, Deaton graduated helpful people: Deaton remembers in price responses, as well as the in 1967. He went to work in the Ken Wigley, who was to move later homogeneity condition that, if (embryonic) research department of to the OECD, and Gwyn Aneuryn- prices and income both increase the Bank of England. But his mind Evans, who was starting to bring by the same percentage, the was elsewhere: he had a girlfriend econometrics into the Faculty. And, consumer’s ideal bundle of goods who was a doctoral candidate above all, the coffee was good – for consumption will remain in English at Cambridge, and he specially brewed and served by the unchanged. wanted to come back to get married. concierge’s wife. This model, the origins of which In 1969 he was appointed as a Junior In association with his University can be traced back as far as the 19th Research Officer in the Department post, Deaton became Fellow and century, had been the object of of Applied Economics, working Director of Studies in Economics criticism, mainly on account of its on national wealth accounting at Fitzwilliam in 1972, where he restrictive assumptions. By building data in collaboration with Dr Jack remained until 1976, when he was large and detailed databases – a Revell, who was writing his book on appointed to a Chair in Econometrics very big manual task in those days ‘The Wealth of the Nation’ and had at Bristol University. He moved to – Deaton was able to disaggregate been Deaton’s Director of Studies Princeton as Professor of Economics the consumption function so as to at Fitzwilliam. One of Deaton’s and International Affairs in 1983 model heterogeneous consumer tasks was manually to derive and until he became Emeritus in 2016. behaviour, in the context of prepare data held at the offices of Currently he is Senior Scholar in relative price movements among the Registrar of Friendly Societies – a the Woodrow Wilson School at commodities with different income lengthy and tedious assignment. But Princeton. and substitution effects. The it involved interacting directly with outcome – the ‘Almost Ideal Demand primary data which, he says, led him Knight work System’ - gave a rich insight into to start ‘dreaming about numbers’ Deaton’s work has focused on the consumer behaviour, and made and what they might reveal. patterns and drivers of consumption possible the rebuilding of aggregate in developed and developing demand functions to demonstrate When Revell left Cambridge for countries, the form and analysis of that, rather than being wrong, the a Chair at Bangor, in North Wales, the consumption function (linking standard theory had been mis- Deaton became involved with the income to aggregate demand), specified in practice. Growth Programme, led by Richard and the relationships with income, Stone and who was himself to poverty, health and welfare. Deaton’s attention then turned to become a Nobel Laureate in 1984. the study of consumption over time, Deaton worked with Alan Roe on At Cambridge, Deaton, following and the part played by income and ‘Finance for Growth’, concentrating and working with Richard Stone, wealth. The permanent income/ on ‘saving and consumption’, inherited Keynes’ concept of the life-cycle theory argued that which proved to be the start for his aggregate consumption function as temporary variations in income lifetime’s work on human wellbeing. a main driver of economic activity. will lead to individuals adjusting On the pattern of demand, one of their short-term savings behaviour Looking back at life in the Economics Deaton’s early contributions (with so as to smooth their long-term Faculty, Deaton recalls the Coffee John Muelbauer, then at Birkbeck) pattern of consumption to match Room (Faculty Lounge) being was to demonstrate the usefulness their expected long-term income. dominated by Nicholas Kaldor and for empirical work of the standard Moreover, if individuals are rational Joan Robinson, larger-than-life neoclassical theory of consumption. and have good information, guardians of the Keynesian legacy. This took as granted the rationality permanent consumption will move It was not easy for newly-recruited of the consumer in seeking to towards equality with permanent junior academic staff to get access maximise individual utility, and in income. Real-world aggregate to them: they were surrounded by Deaton and Muellbauer’s work, data appeared to confirm these their acolytes and had little time for allowed for limited but interesting relationships. young researchers from the DAE. heterogeneity across individuals, Richard Stone and James Meade, while producing an empirically But Deaton showed that this is by choice, did not engage socially tractable model of demand. The misleading if, as in the textbooks, it 2 is interpreted as the behaviour of people out of poverty. A degree of a representative agent. If a single income inequality is necessary to From the Editor agent were to receive average reward effort and innovation. He has income, and behave rationally, brought all this together in his book consumption should be less smooth ‘The Great Escape’ (2013)**. It is an exciting, if controversial, time to be an than income, what became known economist. There are two major issues: the as the `Deaton Paradox.’ The moral is Recently, in association with state of Economics and economic research; that we have to work with individual Princeton economist (and Angus’s and the state of economics education. agents, not mythical representative wife), Anne Case, he has studied the agents, and that we must model causes of the trend to increasing For the first of these, the charges against conventional microeconomics are that it is realistically what they know and mortality and morbidity among mid- dominated unduly by mathematical models; when they know it. The enduring life white non-Hispanic Americans it lacks empirical relevance, and it fails to take significance of this is to demonstrate with low levels of education (that is, account of developments in cognate subject the importance of evidence-based, High School or less). It is associated areas - psychology, sociology, biology and history finely-grained and comprehensive with increases in drug overdoses, in particular. At the same time, macroeconomics empirical data at the level of suicides and alcohol-related liver is seen as needing to rebuild its intellectual households to make possible the disease. While stagnant real wages architecture after having been unsettled by the re-aggregation of the consumption and the loss of job opportunities financial shock of a decade ago. For the second function – something which the are clearly relevant, the underlying issue, there are lively debates about the scope of the digital revolution and recent work in causes go much deeper: Economics curriculum and its relevance for today’s macroeconomics is helping to carry households in this segment of the students, and about pedagogic philosophy and method. forward. community suffer cumulative inter- generational disadvantages in labour Economics in Cambridge is closely involved in Economic growth and the market opportunities, in marriage pursuit of happiness all of this. Some aspects of what is going on is and child outcomes, and in health. reflected in this year’s issue of Cambridge Economics. This work led on naturally to The challenge demands effective Sanjeev Goyal’s valedictory at the end of his four considering the links between policy interventions: reducing years as Chair of the Faculty shows the outstanding income and poverty. Here, in excessive prescription of opioids is contribution he has made to the development of addition to developing frameworks one; supporting increases in median research and teaching in Economics in Cambridge. for the identification and real wages is another. Matthew Elliott’s review of his own work on risk- measurement of poverty, Deaton shifting in financial institutions is a fine example fully accepts the role of economic Reflecting on current economic and of contemporary empirical research, just ten years since the collapse of Lehman Brothers.